On China’s second half recovery, or the lack of it2 August, 2012, 18:14. Posted by Zarathustra
After China’s Q2 GDP report, we raised scepticism regarding the idea that growth has bottomed in the second quarter and that growth will most certainly pick in the third quarter (or more vaguely, second half). In fact, consensus has probably been calling recovery in the “next quarter” probably since the first quarter.
The confidence on that is mostly based on hope that some massive stimulus or something will come through, and the impact will start kicking in later this year. It is true that some supposedly leading indicators are showing some signs of life. Bank lending has been improving, and PMI are showing some mixed signs of stabilisation. Recent major macro data out from China have been improving from “consistently disappointing” to “mixed”, although there are still quite a few data which suggest that second quarter was not the bottom. Industrial production, electricity output, and rail cargo volume, for instance, did not show signs of stabilisation for Q2. Indeed, rail cargo volume growth has only just turned negative in June.
Of course, the fact that data are still showing deteriorating in June does not mean that things can’t turn around in July. Indeed, the Chinese manufacturing PMI for July was, although lower than market expected, a positive report (except the employment situation perhaps) . On top of that, China has been easing monetary policy and seems to be committed to stabilise growth. Recent bank lending growth has also improved, probably on the back to some sort of window guidance from the government to increase lending to finance projects in order to stabilise growth.
The most obvious key risk is, of course, Europe. Should the euro area break up, it is more or less a no-brainer that the global economy could enter into a deep recession, if not depression. But let’s say it will not happen.
There are a few things to keep in mind when consider the willingness, ability and effectiveness of policy easing.
First or all, the role of capita flows on China’s monetary condition is not well-understood. The balance of payments deficits (reserve account excluded) shows that China is losing foreign exchange reserve. But that has not got a lot of attention. As we have reiterated many times, China’s own excessive liquidity problem in the past is very much created by foreign exchange intervention that forced central bank to create too much money. Now this problem is gone, at least for the moment as capital is no longer flowing into the country. If this is the moment for the dramatic shift of capital flow where the central bank does not need to create as much money as they used to be, easing monetary condition could be difficult.
To better illustrate the point, let us assume that the People’s Bank of China would like to keep exchange rate unchanged, and someone decided to convert his RMB-denominated assets into US$ (say US$10 billion worth of it). If no one else is willing to buy up all those RMB being sold at the market exchange rate, the PBOC will end up be buying US$10 billion worth of RMB while selling US$10 billion worth of foreign exchange reserve (effectively propping up RMB). That US$10 billion worth of RMB has disappeared from the Chinese banking system. In other worse, monetary condition has been tightened. Cutting RRR in an environment as China is in now does not necessarily ease monetary condition. Rather, it offsets the tightening effect arising from capital outflow.
Another thing, as mentioned for a number of times, is the apparently warming up of the real estate market, as we have noted. Bloomberg Businessweek reported yesterday that it appears that the real estate market has bottomed already:
China’s new home prices posted the biggest gain in more than a year, signaling a turning point for the nation’s property market, according to SouFun Holdings Ltd. (SFUN) (SFUN), the country’s biggest real estate website owner.
Home prices last month rose 0.3 percent from June to 8,717 yuan ($1,369) per square meter (10.76 square feet), SouFun said in a statement today, based on its survey of 100 cities. That was the second monthly gain and the biggest rise since June 2011.
As the Chinese government does not really want to see real estate prices rebounding, there have been speculations that China will once again step up regulations on home prices. And perhaps unsurprisingly, there are some chatters that the government will indeed step up the regulations. Although this is unconfirmed at this stage, it is not hard to imagine that further restrictions on real estate transactions and so on at this moment in time would be the last thing the economy wants, if getting growth all you want. As we mentioned last time:
… we do not see ways that the government can tighten one part of the economy (in this case, the real estate market) while at the same time stimulate the rest of the economy. If the central government does decide that it is time to tighten the real estate market again, this could come in a rather unfortunate moment as the overall economy is slowing much more rapidly than both the government and the market previously thought. Not to mention the impact of real estate market tightening on industries both upstream and downstream.
We are not convinced that real estate market in China could have reached the bottom if the government loosen at this point, but tightening will certainly be bad for the overall economy.
On top of that, we have also just highlighted the unknown risks of inflation arising from the recent increase in global agricultural commodities prices. Although we continue to believe that the debt deflation story to dominate in the months and quarters ahead, a spike in inflation in the near term could also lower the prospect of more significant easing.
So what exactly are we thinking? First of all, we remain sceptical on the notion that second quarter was the bottom for growth that China will not go below that. We do understand the arguments that stimulus will help, and some signs of life are seen in some indicators, but our fear remains that should growth recover, it is going to be a blip, not a sustained one until something very huge is announced (and even then, there are reasons to be not impressed by huge stimulus).